Expedia: Diller's Buyback Plan Does Create Value

Breakingviews is printed every day on the back page of the C section in the Wall Street Journal. The column sometimes has some interesting things to say, but most of the time it's dedicated to stating an opinion and backing it up with circumstantial evidence.

Monday morning, the column (subscription required) stated quite confidently that Expedia's plan to buy back 42% of the company's shares was a waste of shareholder cash on an overvalued asset (Expedia shares being the overvalued asset). The evidence? Expedia is trading at 26x per share earnings, and the debt level would equal ~4.5x debt/EBITDA.

Well, the problem with Breakingviews is that they take about ten minutes to research a company and not two weeks. I happen to have done a lot of research into Expedia, and while I did not own it in the Vestopia portfolio I manage, my hedge fund owned loads of it - we bought it at ~$18 late last year. Here's why Diller's buyback creates value:

Expedia had about $600M in adjusted operating earning in the last 12 months. By "adjusted" I mean that I take out a lot of the accounting charges that the company is required to take for the amortization of intangibles. Anyway, let's assume that the company spends the $3.2B in debt to buy back shares at the top of the tender offer range - $30/share. That would retire ~107M shares, leaving Expedia with ~244M shares left (adjusted for outstanding options). Assuming an 8% cost of debt (which is mind-blowingly conservative - Expedia will likely pay 100bp below that), that means that from the $600M in operating earnings, ~$250M will go to interest payments. That leaves about $1.50 in operating earnings per share of Expedia stock. Tax that at 30%, and you get about $1/share in free cash flow.

Now, one might argue that a 3.33% FCF yield is low (with the stock at ~30/share presently). I would argue that for a company with presently trough margins, incredibly low capital intensity, and high-single digit revenue growth for as far out as the eye could see, a 3.3% FCF yield is pretty good. Even a bit cheap. As for full disclosure, my hedge fund unloaded Expedia yesterday after the run-up.

My fair value estimate for the stock before the buy-back announcement was ~$28/share. After the buyback announcement, I calculate a fair value of $35/share. Not a bad increase in value. Diller was simply selling a rich asset (debt) and buying back a relatively cheap asset (his stock). That's good capital allocation, and it's unsurprising from someone who own 50% of the company.

EXPE 1-yr chart:

Comments

[weiwentg:]

S&P downgraded Expedia's debt to junk, and Moody's (I think) downgraded them to one step above junk. Since I'm long EXPE, I'd hope that 8% cost of debt is conservative, but it might not be.

2007 Jun 23 10:06 PM